FE Editorial : Economics of haircuts

SummaryThe Central Electricity Regulatory Commission promising to rule soon on whether or not Tata Power can raise tariffs, and by how much, of its 4000 MW Mundra ultra mega power plant should come as a big relief given how the company stands to lose around Rs.1,500-1,800 crore each year by producing at uneconomic rates.

The Central Electricity Regulatory Commission (CERC) promising to rule soon on whether or not Tata Power can raise tariffs, and by how much, of its 4000 MW Mundra ultra mega power plant (UMPP) should come as a big relief given how the company stands to lose around R1,500-1,800 crore each year by producing at uneconomic rates. To make profits at the 16% allowed by the government, the company needs a tariff hike of around 75-80 paise per unit, something no buyer is agreeing to, and that's why the case is before the CERC. If the CERC rules in favour of the Tatas, at some point, this will set the stage for renegotiation for other UMPPs that are stuck in the same frame as the Tatas—it assumed prices of Indonesian coal on which the plant was based would not rise much—like the Reliance Power plant at Krishnapatnam.

While that would be great news for the promoters of these power plants and would kickstart the stalled investment process in the country, the move needs to be considered with caution. It will hit state electricity boards who will now have to pay the Tatas—and later the Adanis and Reliance Power—a higher tariff without necessarily being able to pass this on to their consumers. The larger issue, however, is of what this does to investment discipline since it opens doors for all bidders who won projects in more euphoric times to now renegotiate them at more comfortable rates. Let's not forget the Tatas who bid to supply power at R2.26 per unit had a choice to make their cost of coal variable—but by restricting the amount that was escalable to just 45%, the Tata bid was lower than others and they won the bid. If CERC is to allow the Tatas to get a higher escalable amount, this is tantamount to reworking the contract, and other bidders can legitimately complain that they could have won the bid had a higher tariff been allowed in the first place—ironically, the Tatas have challenged the Reliance Group’s Sasan bid on grounds that post-tender changes had been made.

But given that times change, not allowing renegotiation isn't sensible either since that means the country will lose out on important productive capacity not coming on stream—indeed, banks that have lent to the project also end up losing big money. Indeed, given the large number of